Online Investing Hacks

Editor's note: Bonnie Biafore offers 100 tips and tricks to help you get a better handle on your finances in her new book, Online Investing Hacks. In this sample excerpt, Bonnie walks you through the steps you should consider in order to pick the best brokerage (or broker) for your trading style, and your pocketbook.

Pick the Best Broker for Your Trading Style

Commissions and fees can take a big bite out of your investment returns, so
you should consider your typical trading patterns to determine the most costeffective
brokerage.

Every time you buy or sell an investment, you pay brokerage commissions. If
you trade frequently or make purchases with only a few dollars, commissions
can consume a big percentage of your returns. It makes sense to find
the brokerage that executes your trades at the best possible price, but commission
schedules are a complicated business. Brokerages charge different
commissions based on a number of criteria. It's almost impossible to capture
all the subtleties of brokerage commissions, because each company calculates
commissions a little differently. However, you can build a
spreadsheet to estimate your annual brokerage commissions based on the
methods and frequency of your trades.

Brokerages often charge different commissions depending on whether you
place your trades online, use a touch-tone phone system, or speak to a broker.
In some cases, market orders cost less than limit orders [Hack #54]. Many
brokerages offer discounted commissions for investors who trade frequently—
typically a minimum of 72 trades a year. For trades that represent
a large number of shares or high dollar values, commissions are often calculated
using a minimum commission plus a small percentage of the trade
amount. In addition, bond and option commissions have their own schedule
of fees. In many cases, brokerages charge the same minimum commission
whether you buy one or nine bonds, and only switch to a sliding scale
when you reach ten bonds or options contracts.

Estimating Commissions

The spreadsheet in Figure 9-1 offers a rudimentary comparison of the commissions
you might pay to different brokerages. The calculations take into
account the number of market and limit orders you estimate that you make
in a typical year (cells B2 and B3), the number of bonds and options contracts
you might purchase (cells B5 and B6), and the percentage of trades you place online (cell E2), using a touch-tone phone system (cell E3), or
speaking directly to a broker (cell E4).

Figure 9-1. Create a spreadsheet to determine which brokerage's commission schedule
works for you.

The spreadsheet displays na (not applicable) in the value cells and highlights
the cells with red if a brokerage doesn't handle a type of trade or a type of
investment, as in the case of ShareBuilder [Hack #57], which offers only online
trades and only for stocks. If you like a service the brokerage provides, such
as ShareBuilder's ultralow commissions for trades placed on Tuesdays, you
can set up accounts with two brokers.

This spreadsheet oversimplifies the calculations for active trader discounts,
because it compares the total annual trades you estimate to the annual number
of trades required by a brokerage. Unfortunately, most brokerages determine
the active trader discount quarterly, so the commissions shown in the
spreadsheet might be lower than the ones you pay.

To get an idea of how to build formulas to calculate commissions, dissect
the one for online limit orders. The formula in Example 9-1 uses nested IF
functions to incorporate the active trader discount and to display na if the
brokerage doesn't handle the trade type.

The outer IF function in Example 9-1 checks whether the commission rate for
the brokerage is na. If it is, the function propagates na to the cell that represents
the commission paid (C13). Otherwise, the commission you pay is
based on the number of trades and the charge for the type of trade and access.

The IF function in Example 9-2 calculates the commission rate for the third
parameter in Example 9-1. It checks whether the total number of stock
trades is less than the active trader minimum (cell B10). If the number of
trades is less than the minimum, the function selects the standard commission
rate (cell B13). Otherwise, it adds the active trader discount (cell B11)
to the standard commission rate.

Example 9-2. The IF function for calculating the commission rate

commission rate = IF(total<B$10,B13,B13+B$11)

The formula in Example 9-3 summarizes the calculation for the third parameters
of the IF function in Example 9-1. It multiplies the commission rate by
the number of trades for the type of trade and by the percentage of trades
performed using the type of access. The cells for the number of trades that
you estimate use named ranges. The named range for cell B2 is market_num.
The named range for cell B3 is limit_num. Likewise, the percentages for
types of access use named ranges: cell E2 is online, cell E3 is telephone, and
cell E4 is broker.

Example 9-3. Multiplying the commission by the trade and access type

commission paid = commission rate * limit_num * online

Bond and option commissions typically fall into one of three categories:

Zero

If you don't purchase any bonds or options, of course you won't pay
any commission.

Minimum

Many brokerages charge a minimum for ten or fewer bond or option
contracts. You pay the same amount whether you buy one or ten.

By number

After ten bonds or options, you pay a dollar amount per bond or contract.

To accomplish this rate schedule, the bond and option commission formula
looks like the one in Example 9-4. Whether you purchase zero bonds or
more than ten bonds, the commission you pay is equal to the commission
rate per bond multiplied by the number of bonds. However, if the number
of bonds is between zero and ten, you pay the minimum. The interior IF
function uses a nested OR function to check for a number of bonds equal to
zero or greater than ten. In this spreadsheet, the commission equals the
commission rate for a block of ten bonds multiplied by the number of bonds
and then divided by ten to obtain the commission per bond. If the brokerages
that you are considering calculate their commissions using another formula,
you'll have to modify the formulas in the spreadsheet cells
accordingly.

Example 9-4. A formula for calculating both the minimum commission and a commission
by number of bonds or options

Choosing the Best Deal

Unless you can accurately predict how many trades you will make of each
type and then accurately model the commission calculations for each brokerage
you evaluate, it's impossible to compare commissions to the penny.
Even a spreadsheet provides only a rough guide to your expenses. In addition,
you'll notice that several of the brokerages in Figure 9-1 charge similar
commissions. So, how do you put this information to use? It depends on
how you trade.

If you place only four trades each for $10,000, the difference between
BrownCo ($40) and Schwab ($119.80) is only $79.80—a mere 2/10 of a percent
of the dollars that you're investing. In this case, the commission rates
aren't a concern. Choose the broker that offers the services you want.

However, if you are just starting out and want to invest a few dollars each
month in several different stocks, most of the commissions would overwhelm
the dollars invested. As illustrated in Figure 9-2, an investor who places 6
market orders a month for a total of 72 trades in a year can face a huge difference
in commissions. By buying companies on a regular schedule with Share-
Builder, the investor pays only $152 in commission. BrownCo charges a very
reasonable $400 for trades placed whenever you want. At the other end, the
investor would pay $2,276 to Schwab for those 72 market orders.

When you trade somewhere in between these two examples and all the brokerages
in your spreadsheet satisfy your service requirements, look for the
brokerage with the lowest total commission. In this case, it's a good idea to
add a few more rows to the spreadsheet to account for fees for maintenance,
transferring assets, and issuing certificates. In some cases, high ancillary
fees offset low commissions.

Figure 9-2. Finding the winner when you trade frequently.

Bonnie Biafore
writes about project management, personal finance, and investing. She's the author of Project 2007: The Missing Manual, as well as Online Investing Hacks, QuickBooks 2008: The Missing Manual, and Quicken 2008: The Missing Manual. Bonnie Biafore's blog can be found at http://projectsinpractice.com.